Andy Langenkamp: Sippin’ on geopolitics & economics

October 10, 2023

^{This column was originally written in Dutch. This is an English translation.}

By Andy Langenkamp, Senior Political Analyst at ECR Research and ICC Consultants

In his hip-hop summer classic Gin & Juice, Snoop Dogg is laid back as always, but never loses sight of making money: 'With my mind on my money and my money on my mind.'

That's a wiser attitude for investors this summer than what DJ Jazzy & The Fresh Prince advocated in their summer hit: 'Summer, summer, summertime. Time to sit back and unwind.' Because we saw strong movements in the currency, stock, bond and energy markets. In recent summer months, it has been worthwhile not to lie under a sunshade with a cocktail and forget about the markets for a while, but to crawl behind the screens with a coffee.

War lessons

The end of summer certainly does not mean the end of volatility in the financial markets. On the contrary, there is enough going on politically to set the markets in motion.

First of all, of course, the renewed Israeli-Palestinian conflict. The biggest surprise of last weekend is that the attack came as such a huge surprise, given the reputation of the Israeli (and American) security services. This means that uncertainty will continue to grip investors for the time being and that predictions should be made with caution.

Our analyst team agrees with what the markets are saying now: they are wary, but signal that they expect the crisis to be limited to a regional conflict with limited global consequences. Although the oil price could rise further if, among other things, talks on normalization of relations between Israel and Saudi Arabia stall and/or if America decides to increase (enforcement of) sanctions against Iran due to alleged Iranian involvement in the Hamas attack.

Which brings me to the Ukraine war. Rising oil prices will boost Russia's revenues, especially if supplies from Iran stall and Riyadh maintains production restrictions for longer. This gives Russian leader Vladimir Putin more room to maintain and possibly intensify his war against Ukraine. The long-announced spring offensive, which ultimately became a (meager) summer attack, can now be called a disappointment. Lessons from previous wars teach that there is a greater chance that the battle in Ukraine will continue for a long time:

• American presidents Harry Truman and Dwight Eisenhower were largely guided by domestic political considerations in their position in the Korean War. For example, Eisenhower partly ensured that the armistice negotiations lasted much longer than necessary, because he felt that he could not make compromises in an election year.
• The Korean War was initiated by North Korea with the support of Joseph Stalin and Mao Zedong. At a time when the war was becoming very painful for China, Beijing tried to gently move Stalin towards support for an armistice. The Russian leader was having none of it: “This war is getting on America's nerves…[they] understand that this war is not beneficial and that they have to put an end to it… Endurance and patience are needed here.” Putin could calculate that the Americans will get tired of the war and gamble that Donald Trump will win the presidential elections, with whom Putin can do better business.
• In a war that continues for a long time, the goals pursued by the warring parties almost inevitably shift. During the Korean War, Mao initially wanted nothing more than to defend China, but he became overconfident and thought, among other things, that he could drive the Americans off the Korean peninsula altogether. That turned out to be an incorrect assessment, to say the least. A year later, more than half of all Chinese state income went to the war. This shows that Putin may be able to continue his war for much longer than many think.
• Escalation on the weapons ladder is not imaginary. In 1899, the international community banned poison gas. Less than two decades later, first the Germans and later the Allies used poison gas. During World War II, it suddenly became acceptable for the Allies to bomb German civilians as a primary target, not to mention Hiroshima and Nagasaki.
• In a war, the people at the controls can react unpredictably and surprisingly. In 1953, for example, through a headstrong action by the South Korean president. He unilaterally released 27,000 North Korean prisoners of war, blowing up a reached agreement and provoking the largest communist attack in two years, resulting in 30,000 dead South Korean soldiers. As Margaret MacMillan wrote in Foreign Affairs: 'Leaders with the power to take their countries into war – or hold them back – can rarely be considered mere machines tabulating costs and benefits… Emotions – resentment, pride, fear – can influence decisions great and small .' We have now also seen this in Putin's motivations.
• Only under pressure and with a bit of luck can warring parties reach an agreement. Eisenhower's threat of escalation, the collapsing Chinese economy and Stalin's death formed the basis for the eventual Korean armistice. Translated into the present, this means that Putin will probably only compromise if Ukraine can inflict serious defeats on the Russian army and/or if the Russian economy and society is cracking to such an extent that Putin's position is threatened from within. For the time being, Putin's position appears unthreatened.

Chinese vassal?

The Kremlin is increasingly leaning on China. Putin will welcome that closer relationship with Beijing, but will be wary of giving himself too much over to China's embrace. For example, Moscow has said it will open the port of Vladivostok to Chinese transit trade (for the first time in more than 160 years).

Russia gained control of the bay on which it built the port in 1860 during the Second Opium War. At the time, the Russians threatened to set Beijing on fire. As Russia weakens further, Xi Jinping may conclude that he can more easily play his nationalist cards by regaining a province lost to Russia than by risking a world war over Taiwan with the US, among others, as a formidable opponent.

Thundering Trump train or inevitable derailment?

There are a number of doubts about the US itself and its course on the world stage, which arise, among other things, from the fast approaching presidential and congressional elections next November. Biden will - if he remains in good health - represent the Democrats, but the real spectacle will of course be found among the Republicans. The GOP candidate to beat – Donald Trump – is now embroiled in a handful of criminal charges. The coming months are likely to be a bizarre spectacle, with Trump going from courtroom to campaign rally and having to divide his energy, money and time between them.

His most direct challenger – Ron DeSantis – has so far disappointed, but so far other candidates have not been able to make a dent in either. That could change. In 2015, Jeb Bush was the dead-set Republican presidential nomination. Until a man with the initials DT entered the ring.

If it becomes clear in the coming months that Trump is heading for the nomination unthreatened despite his legal problems, investors could already discount the risk of political chaos in Washington and on the world stage. The question then is whether the dollar and US government bonds will retain their safe haven status or whether investors will prefer gold.

Moreover, Democrats and Republicans must agree on the budget again in the coming weeks. There is already a lot of speculation in the media and by research houses and banks about a government shutdown. Given the sometimes shocking actions of some politicians in Washington, we cannot rule out that the government doors will be locked. This could – if things really get out of hand – lead to a rise in EUR/USD.

Chinese fiasco

Elections are not an issue in China, but the economic prospects are even more so. The expected post-corona recovery has become a fuss and fears of a crisis, prompted by a collapsing real estate sector, remain prominent.

Investors may fear that Xi Jinping wants to please citizens through other means, for example by playing the nationalist card and increasing tensions with Taiwan. If he wanted to do that, Xi will at least wait until next year. There will be elections in Taiwan in early 2024. If the opposition, which is more friendly to the mainland, wins, Beijing can gain more control over Taiwan and Xi can keep the military cards close to his chest.

All in all, it is anything but Time to sit back and unwind and investors must continue to monitor international political developments very closely with their mind on their money and their money on their mind.

More columns by Andy Langenkamp